RULE MAKER PORTFOLIO
Disruptive Technologies in the Publishing Industry
Which publishing industry? All of them

By Rob Landley (TMF Oak)

GAITHERSBURG, MD (December 23, 1999) -- I have been provoked, but in the holiday spirit of charity and forgiveness, I'm going to hold off on a full-blown response to Matt's Monday article about Microsoft (Nasdaq: MSFT) until the new year. I'll even try to say something nice about them: Windows 2000 is bound to sell like hotcakes, since if "Windows 98" was really year 2000 compliant, wouldn't they have called it "Windows 1998"? (You'll notice I only said I'd TRY to say something nice.)

However, I must admit I'm surprised that yesterday's resignation of Microsoft CFO Greg Maffei is still considered news, considering the flood of officers and vice presidents who have either left Microsoft or gone on "indefinite leave" in the past couple of years -- including both Nathan and Cameron Myrvhold, Chris Peters, John Ludwig, Steve Perlman, Pete Higgins, Sam Jadallah, Peter Neupert, Brad Silverberg.... Sheesh, even second-in-command Steve Ballmer has only been on the job for about a year. But again, it's Christmas, so I won't go into it -- yet.

Instead, I'd like to talk about the continuing impact of disruptive technologies on the publishing industry. Which publishing industry? All of them: books, magazines, music, videos, software.

The force impacting all of these is the digitization of content. Text, music, and video is simply "data" to a computer. Music has been stored on digital CDs for 20 years. Text has been typeset digitally for almost as long. Even the newest movies are available on purely digital DVD, and we all know about software.

Before computers, publishers served a valuable purpose. They published information, making copies and distributing them to consumers. (That's what publishing MEANS.) And to regulate various publishing industries, the legal notion of copyright was invented to say who had the right to make copies of a given piece of information.

Back when printing a book or a newspaper required a huge capital investment in a printing press, copyrights were easily enforceable. Copies were made by companies big enough to sue, and they had assets to confiscate in order to pay off the lawyers. Copying audio onto vinyl LPs and even early CDs required similarly expensive huge presses for mass production. Printing movies onto film not only required exotic equipment, but relationships with theaters willing to show the finished product.

Cracks in this model appeared with the introduction of recordable cassette tapes (which horrified the music industry, but became big in Europe and forced their way into this country due to consumer demand). Copy machines from Xerox and others annoyed print publishers, and VCRs deeply concerned the movie industry. But like all disruptive technologies, these technologies created new markets and forced themselves upon the industry. Home video rentals (and even direct-to-video movies) couldn't exist without video tapes. Portable cassette tapes could go into cars or handheld devices (like Sony's Walkman) where LPs had no chance of following. And before fax machines entered the home, the big Xerox and Cannon copiers were too expensive to be used by anyone except big companies big enough to be legally intimidated into respecting copyrights.

The first wave of new technologies simply made copyright enforcement harder, and by necessity selective. The FBI warning may be at the start of every videotape, but police sting operations focus on criminals making hundreds of illegal copies and selling them. There's no point in hunting plankton; they go after the biggest fish first.

Now all this stuff is data stored on computers. From the computer's perspective, any data file is just a huge number, with page after page of digits. Which numbers legally belong to somebody and which are just numbers is not a concept a computer is equipped to cope with. (Rather a lot of computer users have philosophical problems with this concept as well, once they stop and think about it.)

The end result of this is that "piracy" of text, music, and soon movies is a casual activity available to individuals. E-mailing a friend an MP3 file of your favorite song takes only seconds. One of my favorite authors, Dave Barry, has had his own column about an exploding whale forwarded to him so many times (from people who didn't know he wrote it) that he mentioned the phenomenon in another column. I myself have had to explain Fool.com to several people who've read one of my columns and e-mailed me to find out if I'd written any others.

Outlawing this kind of piracy is like passing a law against suicide. Sure it's illegal, but how do you enforce it? Pragmatically, the Internet is great at cutting out the middleman, and like it or not, publishers are middlemen between the creators and the consumers of content.

The software industry has dealt with this since day one. Decades ago, they tried the copy-protection approach the DVD and SDMI (Secure Digital Music Initiative) people are now pursuing, to somehow make the computer recognize and refuse to copy certain information. But the inescapable fact is that if the computer can use it, the computer can copy it. That's just how computers work. How do you view a Web page except by downloading a copy? How do you run a program except by loading a copy into memory? Making data usable yet uncopyable is a contradiction in terms.

The software industry evolved three distinct responses to the problem.

The method Microsoft uses is to beef up the enforcement mechanisms to supernatural levels, literally forcing every potential customer to buy a copy of the product whether they want it or not, by preventing the sale of "blank" anything. A computer that sells without Windows on it is a potential opportunity for Windows to be pirated, so they lock down all the distribution channels (Dell and Compaq and everybody) with exclusive contracts forbidding the sale of bare machines.

This is also the approach the recording industry is trying to take by imposing a surcharge on blank CDs (now that CD burners are cheap enough for individuals to own). They also tried (unsuccessfully) to put a surcharge on blank audio tapes back in the 1970s. This approach is based on the desire to collect a profit whether the consumer decides to buy the product or not, and tends to tick off consumers big time. (The antitrust people get miffed, too.)

The other extreme is the Free Software movement I've talked about before. Free Software has been around as long as computers have, it's just that the commercial software had a big head start on PCs and stayed ahead of the free stuff until the commercial PC world stalled a few years ago. (When Windows 98 didn't outsell Windows 95, Intel had to introduce the Celeron, and commercial software writers everywhere started writing more Web pages than Windows programs.) This approach is based on the fact that the traditional publishing dynamic fundamentally changes when the distribution cost literally goes to zero, and a whole new economic model emerges. You can afford to give copies away for free because making the copies IS free, and all you're left with is the cost of creating the original content. As anyone who has ever read a newspaper's "letters to the editor" or the Fool's own message boards knows, people create content all the time. The trick is filtering out the good stuff from the flood of garbage, and that's a profitable niche serviced by companies like Red Hat (Nasdaq: RHAT) and Andover.net (Nasdaq: ANDN).

The third way is what most software companies do: focus on creating a constant stream of fresh content. Price it to sell quickly, before the market is saturated. Guilt people into paying for a real copy the same way PBS stations solicit donations, and don't price yourself out of range. After a while, the value of the old stuff declines because enough people have it that potential customers can get it from a friend. Maybe it could be included in a "best of" collection later, but in the meantime there's the next version ready to ship.

Websites like the Fool work on approximately this model. The reality is, we're competing with free, and we have to factor that into our market plans. People do e-mail these columns to each other, and we can't stop them. We can ask them not to, which counts for something, but this is not a solution. The solution is to compete with free. We have the home ground advantage, as Fool.com is where the content originates. We can make our archives the best place to get the back columns, and make the fresh ones free and convenient (paid for by advertising, from a fast Web server) so that pirating it by e-mailing copies to friends (and denying TMF the advertising revenue) simply isn't worth the effort. Just forward them a link to the site. We LIKE it when they do that. We get ad hits. Money. Good stuff.

The truth is, pragmatically responding to market pressures by lobbying for new laws to protect the old markets (e.g., the "digital millennium copyright act") is not a feasible long-term solution. If the free market can meet the needs of customers in a cheaper way, it will. Despite all the gripes about making money on the Web, people keep putting up more and more Web pages. Some make money, some don't need to, and that's the free market. If all the MP3 files flying back and forth deny revenues to musicians and really do reduce the amount of music being produced, the people annoyed enough to care will pay to commission more. The recording industry's complaining won't change anything; all they can hope to do is delay the inevitable. A new equilibrium will establish itself eventually, and there WILL be profitable niches in there. And if the old companies aren't in the new niches, tough.

It's amazing how violently people can fight against the free market in the name of protecting the free market, isn't it?

- Oak


 




Rule Maker Portfolio

12/23/99 Closing Numbers
Ticker Company Dly Pr Chg Price
AXPAMER EXPRESS7/8$159.25
CHVCHEVRON CORP11/16$86.44
CSCOCISCO SYSTEMS15/16$104.44
DPHDELPHI AUTOMOTIVE SYSTEMS9/16$15.50
EKEASTMAN KODAK3/8$63.44
GMGENL MOTORS7/16$72.81
GPSGAP INC1/2$43.75
INTCINTEL CORP5/8$83.13
KOCOCA-COLA CO3/4$59.25
MSFTMICROSOFT CORP-1/8$117.44
PFEPFIZER, INC3/8$34.13
SGPSCHERING-PLOUGH7/16$44.56
TROWT.ROWE PRICE ASSOC1/8$35.38
XOMEXXON MOBIL CORP13/16$83.81
YHOOYAHOO INC-16 11/16$402.63

  Day Week Month Year
To Date
Since
2/2/98
Annualized
Rule Maker .87% 3.60% 14.63% 39.84% 74.12% 34.12%
S&P 500 1.56% 2.62% 4.99% 18.64% 48.77% 23.40%
S&P 500(DA) 1.56% 2.62% 4.99% 19.22% 50.54% 24.18%
S&P 500(DCA) n/a n/a n/a n/a 33.47% 16.51%
NASDAQ .82% 5.77% 18.98% 81.03% 145.12% 60.74%

Trade Date # Shares Ticker Cost/Share Price LT % Val Chg
2/17/9916YHOO126.309$402.63218.76%
6/23/9875CSCO32.865$104.44217.78%
2/3/9859MSFT49.352$117.44137.96%
5/1/9882GPS22.708$43.7592.66%
2/13/9859INTC50.624$83.1364.20%
5/26/9818AXP104.067$159.2553.03%
3/12/9820XOM64.335$83.8130.28%
2/3/9866PFE27.433$34.1324.39%
3/12/9817GM60.399$72.8120.55%
2/3/9856TROW33.673$35.385.05%
3/12/9815CHV83.343$86.443.71%
3/12/9820EK63.148$63.440.46%
8/21/9844SGP47.993$44.56-7.15%
3/12/9811DPH17.202$15.50-9.89%
2/27/9827KO69.107$59.25-14.26%

Trade Date # Shares Ticker Cost Value LT $ Val Ch
6/23/9875CSCO$2,464.86$7,832.81$5,367.95
2/17/9916YHOO$2,020.95$6,442.00$4,421.05
2/3/9859MSFT$2,911.79$6,928.81$4,017.02
2/13/9859INTC$2,986.79$4,904.38$1,917.59
5/1/9882GPS$1,862.06$3,587.50$1,725.44
5/26/9818AXP$1,873.20$2,866.50$993.30
2/3/9866PFE$1,810.58$2,252.25$441.68
3/12/9820XOM$1,286.70$1,676.25$389.55
3/12/9817GM$1,026.78$1,237.81$211.04
2/3/9856TROW$1,885.70$1,981.00$95.30
3/12/9815CHV$1,250.14$1,296.56$46.43
3/12/9820EK$1,262.95$1,268.75$5.80
3/12/9811DPH$189.22$170.50($18.72)
8/21/9844SGP$2,111.70$1,960.75($150.95)
2/27/9827KO$1,865.89$1,599.75($266.14)
  Cash: $135.63  
  Total: $46,141.25  


Notes
The Rule Maker Portfolio began with $20,000 on February 2, 1998, and it added $2,000 in August 1998 and February 1999. Beginning in July 1999, $500 in cash (which is soon invested in stocks) is added every month.